FOREX-Surprise Fed rate cut shakes dollar, yen struggles

(Adds details, updates prices)

By Lucia Mutikani

NEW YORK, Jan 22 (Reuters) - The dollar fell against major currencies, except the yen, on Tuesday after the Federal Reserve unexpectedly slashed its benchmark overnight lending rate in an attempt to allay market fears of a U.S. recession.

The Fed's emergency move to cut rates by three quarters of a percentage point was precipitated by a global equities market rout.

The central bank's move wiped out the dollar's yield advantage over the euro, with the federal funds rate target now at 3.5 percent and official euro zone interest rates at 4 percent. This put the European currency on track to post its biggest one-day gain against the dollar in two years.

The cut, which preceded next week's Federal Open Market Committee monetary policy meeting, was not enough to prevent U.S. stocks from falling sharply when the market reopened after Monday's public holiday. Stocks, however, recouped some of their opening losses. For details see [.N].

"Under any other Fed this would not be a surprise, but this Fed has been reluctant to cater to market expectations," said Mark Meadows, currency strategist at Tempus Consulting in Washington.

"This should support the euro in the short term, however our long-standing view is still that the U.S. economy will rebound and help the dollar gain into the middle of this year."

In New York afternoon trade, the euro was up 1.2 percent on the day at $1.4613 EUR= after briefly racing to $1.4643. The euro has rebounded from a one-month low against the dollar of around $1.4366, according to Reuters data.

Tuesday's emergency step was the biggest rate change since November 1994 when the Fed tightened policy by 75 basis points. It was the first intermeeting cut since Sept. 17, 2001.

Analysts said the Fed's bold rate cut had not changed market projections for the dollar's recovery versus the euro in the second half of the year.

DOLLAR RECOVERY VERSUS EURO INTACT

"The aggressive stance by the Fed together with some stimulus package from the government could potentially insure that the economy bottoms around the middle of the year," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.

"The moment we see that happening we could see a strong and sustained rally in the U.S. dollar."

President George W. Bush has proposed a $145 billion short-term stimulus package to minimize the impact of a U.S. economic slowdown.

Against the Swiss franc, the dollar was down 0.9 percent at 1.0986 francs CHF=, while the pound rose 0.9 percent to $1.9613 GBP=.

The greenback was thumped against the high-yielding Australian and New Zealand dollars. It last traded down 0.6 percent at US$0.8675 AUD= and dived 2.4 percent to US$0.7640 NZD=.

The dollar, however, fared better against the yen, with analysts citing repatriation flows on the back of collapsing equity prices as well as an improvement in risk appetite after the Fed's rate cut.

It traded up 0.7 percent at 106.79 yen JPY=, after earlier touching its lowest in more than two-and-a-half years against the Japanese currency.

But some analysts were sceptical the Fed's rate cut would ease fears of recession and said it pointed to panic by monetary authorities.

"Lower interest rates do little to address underlying weakness in the U.S. housing sector and broader economy. We would not be surprised if it fostered concerns that conditions may actually be worse than many investors anticipated," said strategists at Citigroup in a note.

Short-term interest rate futures were pricing in a quarter-point rate cut at the Jan. 29-30 meeting and showed a roughly 78 percent chance of a 50 basis points cut. The Fed has been cutting rates since mid-September.

(Additional reporting by Nick Olivari; Editing by Chizu Nomiyama)